Interest in a world of abundance (amv)

Modern theory, especially monetary theory, has completely adopted the monetary explanation of interest, which claims that changes in money supply have a permanent impact on the rate of interest. Not many economists, however, would accept the underlying assumption on which this theory of interest ultimately rests. Prof. Hayek (in: The Pure Theory of Capital, [1941]1975, pp. 373-74] makes this key assumption explicit:

"[We have to assume] that not only the supply of pure input but also the supply of final and intermediate products and of instruments of all kinds was infinitely elastic, so that every increase in demand could be satisfied without any any increase of price, or, in other words, that the increase of investment (or we should rather say output) was possible without society in the aggregate or even any single individual having to reduce consumption in order to provide an income for the additional people now employed. Or, in other words, we have been considering an economic system in which not only the permanent resources [labor, land; amv] but also all kinds of non-permanent resources, that is, all forms of capital, were not scarce. There is indeed no reason why the price of capital should rise if there are such unused reserves of capital available, there is even no reason why capital should have a price at all if it were abundant in all its forms. The existence of interest in such a world would indeed be due merely to the scarcity of money, although even money would not be scarce in any absolute sense; it would be scarce only relatively to given prices on which people were assumed to insist. By an appropriate adjustment of the quantity of money the rate of interest could, in such a system, be reduced to practically any level.

Now such a situation, in which abundant unused reserves of all kinds of resources, including all intermediate products, exist, may occasionally prevail in the depths of a depression [like the Great Depression; amv]. But it is certainly, not a normal position on which a theory claiming general applicability could be based. Yet it is some such world as this which is treated in Mr. Keynes General Theory of Employment, Interest and Money, which in recent years has created so much stir and confusion among economists and even the wider public. Although the technocrats, and other believers in the unbounded productive capacity of our economic system, do not yet appear to have realised it, what he has given us is really that economics of abundance for which they have beenclamouring so long. Or rather, he has given us a system of economics which is based on the assumption that no real scarcity exists, and that the only scarcity with which we need concern ourselves is the artificial scarcity created by the determination of people not to sell their services and products below certain arbitrarily fixed prices. These prices are in no way explained, but are simply assumed to remain at their historically given level, except at rare intervals when " full employment " is approached and the different goods begin successively to become scarce and to rise in price. Now if there is a well-established fact which dominates economic life, it is the incessant, even hourly, variation in the prices of most of the important raw materials and of the wholesale prices of nearly all foodstuffs. But the reader of Mr. Keynes' theory is left with the impression that these fluctuations of prices are entirely unmotivated and irrelevant, except towards the end of a boom, when the fact of scarcity is readmitted into the analysis, as an apparent exception, under the designation of " bottlenecks."

Hurray! This reflects all I have ever posted on this blog. Thank you, Prof. Hayek.